My Personal Model

First, a warning to my wife and children - DO NOT read this post and DO NOT attempt this at home. This post is for myself to help me realize - over time - how screwing around with investments does nothing but lose money. So, to my wife and children - stick with the post(s) that I have written for you - and ignore the posts that I have written to myself for they pose dangers to your financial health that you (and probably I) should not take.

While it may not be wise, I follow a more sophisticated allocation model. I probably do so out of impatience and an emotional need for "action" which is undoubtedly fool hearty. My model is grounded in two beliefs.

First, the stock market goes up and down and in theory you want to buy when the market is down and sell when the market is high. The traditional (and safest) way to do this is to set static percentage allocations and re-balance (buy/sell) stocks and bonds periodically (quarterly/annually) to re-establish the static percentages. This will automatically result in selling whichever asset is performing better relative to the other and buying the asset that is under performing.

My concept is to use adjustable re-balancing. In theory I want to actually increase my percentage allocated to stocks when stocks are under performing and to decrease my exposure to stocks when they are over performing. Thus, in a bear market with new 52 week lows being reached, I want to move more assets from bonds into stocks. Likewise, in a bull market with new 52 week highs being reached, I want to move more assets from stocks into bonds. Thus, if I want to generally hold 70% stocks, in theory I want to increase my stock exposure to 80% when stock prices are hitting new 52 week lows. On the flip side I want to decrease stock exposure to 60% when stocks are hitting new 52 week highs. What I have not yet worked out is a mechanical formula to accomplish this.

The second prong of my theoretical investment model is based upon "Modern Portfolio Theory" - the concept that different investments do not go up and down in tandem and that in a "perfect investment world", investment "A" would be the mirror opposite of investment "B" - both being opposite ends of a see-saw - so that when A went down, B went up the exact amount and vice versa. In the real world no such investment exists and, indeed, from my personal observation of long term charts, most investments go up and down together with the overall market. However, they do not go up and down to the same extent and some segments of the market will be out of favor for periods of time and then will eventually come back into favor.

Thus, there would seem to be a benefit to owning various market segments individually IF - and only if - one is buying low and selling high. Thus, my theory is when buying stocks in a bear market, it makes sense to buy those sectors of the market that have been hit the hardest and are thus cheapest. And, likewise, when selling stocks, it makes sense to be selling the sectors of the market that are over bought and selling at the highest premium. Of course, creating a mechanical model to accomplish this is the issue I am still working on. That model will call for most of the portfolio to be in Vanguard's Total Stock Market Index with smaller (adjustable) percentages allocated to small cap stocks, value stocks, small cap value stocks, REIT, and international stocks.